Source: Freeport-McMoRan

While Freeport-McMoRan might have signed an agreement that allows it to begin shipping unprocessed ore from its Grasberg mine in Indonesia next month, and Newmont Mining is in danger of losing its license to do so, it's the latter that may be in the better position after all.

To get to the point where it's allowed to once again ship copper concentrates out of the country, Freeport had to agree to a series of concessions that harms its business and substantially weakens its position. In particular, the copper miner agreed to the following:

  • Build a smelter in Indonesia
  • Post a $115 million bond to ensure that it does build one
  • Pay higher royalties on copper and gold
    • 4% on copper, up from 3.5%
    • 3.75% on gold, up from 1%
  • Pay export tax of 7.5% on copper concentrate shipments during smelter development, down from 25%, declining over time as development progresses and disappearing when it reaches 30%
Still to be worked out is just how much cost-sharing between Freeport and the government there will be on the smelter's development, the requirement the miner give up a 30% ownership stake to either the government or local investors (up from 9.4% currently), and extending its right to operate in the country until 2041.

Those are all substantial concessions Freeport-McMoRan has agreed to, but by doing so it undermines its own standing in the country. For example, what would appear to be one of the strongest points of the agreement it hammered out -- extending its COW for another 20 years, thus giving it assurances of stability -- presupposes the government won't try to change the terms again in the future.

That's what Newmont is fighting right now, why it has rejected all entreaties to return to the negotiating table, and why it is taking its case to international arbiters. It says it already has a contract of work agreement in place with the government and the attempts by Indonesia to rewrite it before its 2021 expiration date are improper. If Freeport signs off on allowing the government to rewrite the terms early this time, it's giving precedent to allowing it to happen again in the future.

The go along to get along strategy will end up costing Freeport significant sums of money in the long run. For example, the combined royalties its Indonesian subsidiary paid last year totaled $109 million, up 17% from 2012. With 91% of all its gold produced last year and more than a fifth of its copper coming from Indonesia last year, that means its costs on the former have nearly quadrupled with the new COW. Its royalties paid as a percentage of its net income jumped from around 4% to more than 15%.

Then there's the bit about giving up some 30% of its ownership to the government or Indonesian nationals. Doing so will actually reduce the amount it receives from its production, meaning the higher royalty rates ought to represent an even higher percentage of its profits. There's just no way this can be seen as a good deal for Freeport or its investors, and is likely why the market didn't react positively to the announcement. The miner has given away the store.

Newmont Mining's more principled stance against the government's rapaciousness may just be the better bet. It's hard to see how disinterested third parties won't look askance at Indonesia's bid to rewrite the rules early since the contracts of work both miners had agreed to specifically permit them to ship unprocessed ore out of country without being subject to taxes, duties, or levies. It was under such agreements that they entered into long-term contracts with foreign ore processors -- contracts that they can't simply breach now.

More importantly, though, the current administration lost the recent presidential elections by a wide margin, and the president-elect has made conciliatory overtures to the mining community. Newmont could just be running out the clock until the new administration takes over, and if the president holds true to take the miner's position into consideration, Freeport-McMoRan will likely have given up all opportunity to rerenegotiate its ill-thought-out agreement.

Although two other miners also recently agreed to pay Indonesia's extortion, Newmont Mining may have chosen the best course of action after all.